CHAPTER 11: DECISION MAKING AND RELEVANT INFORMATION

Welch Manufacturing is approached by a European customer to fulfill a one-time-only special order

for a product similar to one offered to domestic customers. Welch Manufacturing has excess capacity.
The following per unit data apply for sales to regular customers:
Variable costs:
Direct materials
$40
Direct labor
20
Manufacturing support
35
Marketing costs
15
Fixed costs:
Manufacturing support
45
Marketing costs
15
Total costs
170
Markup (50%)
85
Targeted selling price
$255

66.

What is the full cost of the product per unit?

a.
$110
b.
$170
c.
$255
d.
$85
Answer:

Difficulty:

Objective:

Objective:

$40 + $20 + $35 + $15 + $45 + $15 = $170

67.

What is the contribution margin per unit?

a.
$85
b.
$110
c.
$145
d.
$255
Answer:

Difficulty:

$255 ($40 + $20 + $35 + $15) = $145

68.

For Welch Manufacturing, what is the minimum acceptable price of this special order?
a.
$110
b.
$145
c.
$170
d.
$255
Answer:

Difficulty:

Objective:

$40 + $20 + $35 + $15 = $110

69.

What is the change in operating profits if the 1,000 unit one-time-only special order is
accepted for $180 a unit by Welch?
a.
$70,000 increase in operating profits
b.
$10,000 increase in operating profits
c.
$10,000 decrease in operating profits
d.
$75,000 decrease in operating profits
Answer:

Difficulty:

Objective:

$180 ($40 + $20 + $35 + $15) = $70; 1,000 x $70 = $70,000 increase
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159. Kirkland Company manufactures a part for use in its production of hats. When 10,000 items are
produced, the costs per unit are:

Direct materials
Direct manufacturing labor
Variable manufacturing overhead
Fixed manufacturing overhead
Total

$0.60
3.00
1.20
1.60
$6.40

Mike Company has offered to sell to Kirkland Company 10,000 units of the part for
$6.00 per unit. The plant facilities could be used to manufacture another item at a
savings of $9,000 if Kirkland accepts the offer. In addition, $1.00 per unit of fixed
manufacturing overhead on the original item would be eliminated.
Required:
a.
b.

What is the relevant per unit cost for the original part?
Which alternative is best for Kirkland Company? By how much?

Answer:
a.

Direct materials
Direct manufacturing labor
Variable manufacturing overhead
Avoidable fixed manufacturing. overhead
Total relevant per unit costs

b.

Make
Purchase price
Savings in space
Direct materials
Direct mfg. labor
Variable overhead
Fixed overhead saved
Totals

$0.60
3.00
1.20
1.00
$5.80
Buy
$60,000
(9,000)

$6,000
30,000
12,000
$48,000

(10,000)
$41,000

The best alternative is to buy the part.

Difficulty: 2

Objectives: 4, 5, 6

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Effect of Buying
$(60,000)
9,000
6,000
30,000
12,000
10,000
$7,000

161.

Nortons Mufflers manufactures three different product lines, Model X, Model Y, and
Model Z. Considerable market demand exists for all models. The following per unit
data apply:
Model X
Model Y
Model Z
Selling price
$80
$90
$100
Direct materials
30
30
30
Direct labor ($10 per hour)
15
15
20
Variable support costs ($5 per machine-hour)
5
10
10
Fixed support costs
20
20
20
a.
b.
c.
d.
e.

For each model, compute the contribution margin per unit.

For each model, compute the contribution margin per machine-hour.
If there is excess capacity, which model is the most profitable to produce? Why?
If there is a machine breakdown, which model is the most profitable to produce?
Why?
How can Norton encourage her sales people to promote the more profitable
model?

Answer:
a.
b.

c.
d.
e.

The contribution margin per unit is $30 for Model X ($80 - $30 - $15 - $5),
$35 for Model Y ($90 - $30 - $15 - $10),
and $40 for Model Z ($100 - $30 - $20 - $10).
The contribution margin per machine-hour is
$30 for Model X ($30 contribution margin / 1.0 machine-hours per unit),
$17.50 for Model Y ($35 / 2.0), and
$20 for Model Z ($40 / 2.0).
When there is excess capacity, Model Y is the most profitable because it has the
greatest contribution margin per unit.
When there are machine-hour capacity constraints, Model X is the most profitable
because it has the greatest contribution margin per constrained resource.
To encourage sales persons to promote specific products, Norton may want to
provide marketing incentives such as higher sales commissions for products
contributing the most to profits. Norton may also want to educate salespeople
about the effects of constrained resources.

Difficulty: 3

Objective:

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163. The management accountant for the Chocolate Smore Company has prepared the
following income statement for the most current year.
Sales
Cost of goods sold
Contribution margin
Delivery and ordering costs
Rent (per sq. foot used)
Allocated corporate costs
Corporate profit
a.
b.

Chocolate
$40,000
26,000
14,000
2,000
3,000
5,000
$4,000

Other Candy
$25,000
15,000
10,000
3,000
3,000
5,000
$(1,000)

Fudge
$35,000
19,000
16,000
2,000
2,000
5,000
$7,000

Total
$100,000
60,000
40,000
7,000
8,000
15,000
$10,000

Do you recommend discontinuing the Other Candy product line? Why or why
not?
If the Chocolate product line had been discontinued, corporate profits for the
current year would have decreased by what amount?

Answer:
a.

No, I would not recommend discontinuing the Other Candy product line because
this product line contributes $4,000 towards corporate costs and profits.
$25,000 - $15,000 - $3,000 - $3,000 = $4,000
Without the Other Candy product line, corporate profits would be $4,000 less than
currently reported.

b.

If the Chocolate product line were discontinued, corporate profits would

immediately decrease by $9,000.
$40,000 - $26,000 - $2,000 - $3,000 = $9,000

Difficulty: 3

Objective:

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164. Pat, a Pizzeria manager, replaced the convection oven just six months ago. Today,
Turbo Ovens Manufacturing announced the availability of a new convection oven that
cooks more quickly with lower operating expenses. Pat is considering the purchase of
this faster, lower-operating cost convection oven to replace the existing one they
recently purchased. Selected information about the two ovens is given below:
Existing
$60,000
$ 5,000
$40,000
5 years
$10,000
$ 0

Original cost
Accumulated depreciation
Current salvage value
Remaining life
Annual operating expenses
Disposal value in 5 years

New Turbo Oven

$50,000
----5 years
$ 7,500
$ 0

Required:
a.
What costs are sunk?
b.
What costs are relevant?
c.
What are the net cash flows over the next 5 years assuming the Pizzeria purchases
the new convection oven?
d.
What other items should Pat, as manager of the Pizzeria, consider when making
this decision?
Answer:
a.
Sunk costs include the original cost of the existing convection oven and the
accompanying accumulated depreciation.
b.

Relevant costs include:

Acquisition cost of the new Turbo oven
Current disposal value of the existing convection oven
Annual operating expenses for the existing and the new Turbo oven

c.

Net cash flows over 5 years with the new Turbo oven:
Cash inflow:
Decrease in annual operating expenses ($2,500 x 5)
Sale of the existing oven
Cash outflow:
Acquisition of the new Turbo oven
Net cash inflow (outflow)

d.

$ 12,500
40,000
(50,000)
$ 2,500

Other items the manager should consider when making this decision include:
The Turbo ovens reliability and efficiency is still unknown since it is a brandnew product.
If the Turbo oven does bake faster as it claims, the Pizzeria may be able to
increase sales due to the quicker baking time.
After purchasing another oven just six months prior, top management should
consider the Turbo oven option, but instead may question the decision-making
ability of Pat, the current manager.

Difficulty: 2

Objective:
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169. A restaurant is deciding whether it wants to update its image or not. It currently has a
cozy appeal with an outdated dcor that is still in good condition, menus and carpet that
need to be replaced anyway, and loyal customers.
Identify for the restaurant management
a.
those costs that are relevant to this decision,
b.
those costs that are not differential,
c.
and qualitative considerations.
Answer:
For the decision of whether to update the restaurants image:
a.
Relevant costs include a one-time cost of the renovation for the updated image,
and a change in future sales which includes an increase in sales due to the updated
image, decrease in sales due to loss of that cozy appeal, and loss of sales due to
being closed or having a limited serving area during renovation.
b.

Costs that are not differential include replacing the menus and the carpet since
they need to be replaced whether the image is updated or not.

c.

Qualitative considerations include whether the restaurant will lose that cozy
appeal it currently has, if the restaurant needs to be closed for renovations it may
result in loss of customers, and new customers may not be the type of customer
they want to attract.

Difficulty: 2

Objectives: 2, 3

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